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Strategic Finance

A Guide to Foreign Currency Translation Adjustments in SaaS

Published on July 19, 2024
Joe Garafalo

Founder and COO

In 2024, the United States (US) was home to approximately 9,100 SaaS companies, collectively serving around 15 billion customers worldwide. It’s widespread for SaaS companies to operate internationally, and unfortunately, that comes with the challenge of handling foreign currencies.

Reporting accuracy is fundamental to understanding a company’s financial health. While that’s hard enough, multiple currencies add more complexity to the mix — that’s where foreign currency translation comes into play.

Foreign currency translation adjustments (FCTA) help ensure clarity and alignment, especially between billing and cash flow, to mitigate currency risk and give you and your stakeholders greater visibility and transparency into your company’s financials.

Table of Contents

Basics of Foreign Currency Translation Adjustments

FCTA is highly relevant for SaaS companies that operate globally or handle multiple currencies. Essentially, this involves converting financial statements from the functional currency, the currency of the primary economic environment, to the reporting currency. This way, you can ensure accurate financial consolidation and reporting.

Adjustment entries reflecting the unrealized gains or losses from currency exchange rate fluctuations are typically recorded on the balance sheet as a Cumulative Translation Adjustment (CTA) entry.

The Accounting Standards for Foreign Currency Translation

FCTA is guided by accounting standards like:

And it’s important to get foreign currency translation right. As a SaaS company serving global customers, you often deal with multiple currencies. By isolating currency impacts through the CTA, you can ensure your consolidated financial statements are accurate, meet foreign currency accounting standards, and make informed decisions.

More importantly, you can clearly report the effects of foreign currency exposures and give stakeholders a transparent view of your financial performance — which truly reflects actual cash flow — across international markets.

Identifying When Adjustments Are Needed

As we’ve covered, when companies operate in foreign countries, they need to account for significant changes in exchange rates. FASB’s Foreign Currency Translation (Statement No. 52) outlines how to handle these changes in financial reporting. Here’s the breakdown:

  • Self-contained foreign operations: For a foreign branch or subsidiary that operates independently, exchange rate changes affect the overall investment in that operation. These changes are recorded as translation adjustments, which don’t affect the company’s cash flows or net income.
  • Foreign operations linked to the parent company: If the foreign operation is closely tied to the parent company’s domestic operations, exchange rate changes impact specific assets and liabilities, directly affecting cash flows. Therefore, gains and losses from these changes are included in net income.
  • Hedging foreign exchange risk: If the company has contracts or transactions that effectively hedge against foreign exchange risk, they are treated as hedges, regardless of their form.

Statement No. 52 (which replaces the old rules under FASB Statement No. 8) basically covers how companies should account for foreign currency transactions and financial statements. It’s meant to shed light on how exchange rate changes affect a company’s cash flows and equity and to ensure consolidated financial statements reflect results in each entity’s primary currency, i.e., the functional currency.

Specifically, you can determine the functional currency by identifying an entity’s main currency in its economic environment, i.e., where it earns and spends cash. Depending on the situation, this currency could be the dollar or a foreign currency. Typically, in countries with very high inflation (around 100% over three years), you can’t use the local currency as the functional currency. Instead, you should use the more stable currency of the parent company.

An entity could be a subsidiary, division, branch, or joint venture. It’s on your company to carefully assess the facts to determine the functional currency.

Mitigating Currency Risk

SaaS companies often have a customer base spread across the globe and usually face challenges with foreign currency translation. That’s because exchange rate volatility (also known as currency risk) can distort a SaaS company’s performance if not correctly accounted for. For example, if you have accounts receivable in a foreign currency that appreciates before payment, you’ll see an unrealized gain.

Similarly, when expanding to new markets, you must determine the best pricing in local currencies while protecting your margins from currency risk.

If you’ve been in this boat before, you probably frequently bill customers in different currencies. And you already know that foreign currency translation is key to ensuring your books are in order.

So, how can you mitigate currency risk? Start your financial risk assessment by thoroughly assessing your allocation.

Then, evaluate how much of your total liquidity is held in foreign currencies and whether these currencies often fluctuate against your functional currency. If possible, denominate your foreign contracts in USD, which is relatively stable compared to other currencies. Revalue foreign currencies at the end of each period to get an accurate picture of your company’s financial situation and comply with tax laws.

Additionally, include clear language in your contracts with defined payment terms regarding currency type and renegotiation clauses in case of severe volatility.

Plus, make sure to leverage natural hedging by matching expenses in a specific currency with the amount you hold in that currency. You can also use foreign exchange contracts to lock in a specific, favorable exchange rate for a future transaction.

Foreign Currency Translation in Action: A Step-by-Step Process

According to ASC 830 and IAS 21, you must record transactions in the functional currency at the exchange rate on the transaction date.

At each reporting period, you then remeasure foreign currency translations to the functional currency using current exchange rates, denominating monetary assets and liabilities in a foreign currency, while recognizing any resulting foreign exchange gains or losses in net income.

When you have foreign subsidiaries, you need to translate their financial statements for consolidated reporting. First, you convert their assets and liabilities into your reporting currency at the current exchange rate. Then, you convert their revenue and expenses at the average rate for the period.

Now, record the differences from these conversions in a separate equity account, i.e., the CTA — this captures the unrealized gains or losses from currency fluctuations and only affects your financial statements when you sell or liquidate the foreign subsidiary.

Example of Foreign Currency Translation

Let’s look at how foreign currency translation works with a hypothetical example.

Imagine a US SaaS company, Company A, has a subsidiary in Australia. The subsidiary earns revenue in Australian dollars (AUD), its functional currency, and reports its financial results in AUD. When Company A consolidates its financial statements, it translates the subsidiary’s AUD into USD (the parent company’s currency). If the AUD’s value drops compared to the USD, Company A reports lower consolidated revenue, but this translation adjustment doesn’t affect actual cash flows.

However, if Company A has an Australian contract tied directly to the parent company’s operations, any exchange rate change directly impacts cash flows and appears in net income. As you can see, this process ensures financial statements show records in the currency each entity primarily uses.

 

Run Multi-Subsidiary Consolidations in 4 Minutes in Mosaic

Mosaic’s Role in Foreign Currency Translation Adjustments

While foreign currency translation sounds really complicated (and it can be), multi-currency billing and real-time currency conversion features in your SaaS finance tech stack can make all the difference.

And with Mosaic, our strategic finance platform built for SaaS, foreign currency translation gets even more straightforward. Here’s how: Billing and payment systems drive your business’s finances. Mosaic integrates with leading SaaS billing and payment systems to give you a clear, real-time view of your cash cycle, helping you confidently plan your liquidity.

Plus, it consolidates data from your ERP, CRM, HRIS, data warehouse, and flat file uploads into a single source of truth and automatically updates any changes — making financial planning and analysis much easier across all teams and locations.

Notably, one of the best ways to assess your company’s exposure to risks, including currency risks, is by viewing relevant metrics. Mosaic has your back. By integrating with your enterprise systems — Xero, Quickbooks, NetSuite, or Sage Intacct — Mosaic provides a continuous, real-time view of your metrics in easy-to-understand financial dashboards.

Moreover, Mosaic handles currency translation adjustments each month and posts them to the General Ledger. Mosaic applies unique foreign exchange rates for each month in the financial statements and automatically recalculates adjustments if exchange rates change. Additionally, Mosaic keeps the balance sheet accurate by making corresponding foreign exchange adjustments in the subsidiary’s CTA account.

That said, protecting your business from risk is just the first step in a broader financial analytics strategy.

The next — and most important — step involves using data-based forecasts and projections to plan your company’s growth. That’s where all your financial analyses come together to chart a clear path to sustainability. And with Mosaic’s what-if scenario analysis, you can view the potential impact of various risks, helping you understand which ones to prioritize.

That said, protecting your business from risk is just the first step in a broader financial analytics strategy.

The next — and most important — step involves using data-based forecasts and projections to plan your company’s growth. That’s where all your financial analyses come together to chart a clear path to sustainability. And with Mosaic’s what-if scenario analysis, you can view the potential impact of various risks, helping you understand which ones to prioritize.

But don’t just take our word for it. See Mosaic in action.

Foreign Currency Translation FAQs

Can foreign currency translation adjustments impact a company's financial health?

Yes, foreign currency translation adjustments can affect a company’s reported financial performance and equity. Essentially, these adjustments can create unrealized gains or losses due to exchange rate fluctuations.

How does Mosaic simplify the foreign currency translation process for SaaS companies?

Are there any industry-specific considerations for SaaS companies in foreign currency translation?

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